February 2007

A February 2007 study by three professors looks at 230 of the U.S.’s largest public company frauds disclosed between 1996 and 2004. The study, entitled “Who Blows the Whistle on Corporate Fraud?” addresses how each fraud was discovered. Consistent with every other study on the subject, employee whistleblowers are the largest discovery mechanism.

Because these were the largest frauds during this period, multiple employees at each company knew at least a portion of what was happening. Consequently, employee whistle blowing could have been an even more important means of discovery. The study notes that employee reporting was not more widespread because employees have considerable disincentives personally. In 82 percent of the cases with employee whistleblowers identified, the whistleblower “alleged they were fired, quit under duress, or had significantly altered responsibilities as a result of bringing the fraud to light.”

The report later notes:


“In no case is the tension between access to information and the lack of incentives to reveal fraud more intense than for employees. Employees clearly have access to information; few, if any, frauds can be committed without involving some interaction among the people within a firm. However, the career incentives against revealing the fraud are stricter for employees than for any other group. … Consequences to being a whistleblower include distancing and retaliation from fellow workers and friends, personal attacks on one’s character during the course of the protracted dispute, and the need to change one’s career.

… The surprising part, thus, is not that most employees do not talk; it is that some talk at all…. The costs of blowing the whistle are eliminated by keeping the identity of the whistleblower concealed.”


In 45 percent of the cases in which employees blew the whistle, the employee remained anonymous. Under Sarbanes-Oxley (which was not in effect for most of the period covered by the study), each whistleblower could have remained anonymous (see Sarbanes-Oxley Section 301(4). Even without such protections that Sarbanes-Oxley provided, the report notes the:


“…paradox of whistle blowing: those with the weakest incentives to blow the whistle (e.g., employees) are the most active, while those with the strongest incentives are surprisingly less frequent actors. …

[This occurs because] information is diffuse. Actors with weak incentives have an advantage in whistle blowing because they have superior access to information about the fraud. So, despite having weak incentives, actors with access to information eventually bring frauds to light. In contrast, those with incentives apparently have difficulty accessing credible information to act upon.”


The study also notes that whistleblowers sometimes have trouble getting the credibility in having others believe their reports. For example, HealthSouth was a large and notorious accounting fraud involving made-up capitalized costs that created both fake earnings and imaginary assets:


“Illustrating this potential problem is HealthSouth, where the fraud would likely have been detected and stopped earlier if the concerns of former b